Feeding the dragon Part 1: China’s energy hunger

As the world’s most-populous country, China is also the world’s largest producer and consumer of energy. It has the world’s second-largest economy and one of the fastest-growing economies, with the International Monetary Fund (IMF) expecting China’s gross domestic product to surpass that of the United States, in purchasing power parity terms, by the end of this decade.1 Rapidly increasing demand for oil and natural gas, both in the recent past and more critically in the future, has made and will keep China a key player in global oil and gas markets.

The oil and gas industry in China, as well as China’s oil and gas activity outside the country, should be viewed in the context of the broader policy objectives of the new Chinese government.2 Under President Xi Jinping, China is embarking on a process of broad economic reform, creating a more balanced and sustainable platform for economic growth – one characterised by greater domestic consumption as opposed to export-led investments. As President Xi noted in a recent speech on the energy sector, China is looking toward more environmentally sustainable growth, implying a reduced share for coal in the country’s energy mix and a greater role for natural gas and renewable energy. It is also moving toward more market-based pricing for energy commodities, as well as encouraging energy efficiency and competition among firms.

Most critically however, in the energy sector, is China’s focus on energy supply security, with that focus having both an external and an internal component. Externally, to secure access to oil and natural gas, China has aggressively expanded its direct acquisition of oil and gas assets, as well as making substantial long-term investments in overseas assets/projects in order to secure long-term future supply and/or gain technical expertise. These acquisitions/investments have been largely made through the three primary national oil companies (NOCs) – Sinopec, CNPC/PetroChina and CNOOC. Not including the huge bilateral oil-for-loans deals, according to data from Derrick Petroleum, these three NOCs have invested almost US$ 150 billion in overseas oil and gas assets since 2005.3

Internally to increase domestic supply and reduce import dependency, the government intends to focus more investment on domestic upstream oil and gas and on renewable energy projects, and is looking for ways to attract more private investment into the upstream sector by streamlining the project approval process, implementing policies to open and expand the transmission infrastructure, and implementing some pricing reforms. The next two sections discuss China’s oil and gas upstream in greater detail.

China’s upstream: status and prospects

Chinese oil reserves at the beginning of 2014 were 24.4 billion bbls, while conventional reserves of natural gas stood at 155.4 trillion ft3. In 2013, China was the world’s fourth-largest oil producer, with production estimated at 4.2 million bpd. Natural gas production in 2013 was estimated at 3.8 trillion ft3. Neither oil nor gas production in China is keeping pace with demand growth, so the country remains a large (and growing) net importer of both oil and gas.

Conventional forecasts of Chinese oil production, such as from the US Energy Information Administration (EIA), see rather modest oil production growth – averaging around 0.5% per year and peaking in 2030 at approximately 4.9 million bpd.4 EIA expects production growth to fall far short of oil demand growth, and China’s oil import dependence to rise. Chinese oil demand is expected to grow from around 10.6 million bpd in 2013 to 16.6 million bpd by 2030 and to 19.8 million bpd by 2040. EIA’s forecast of Chinese gas production is more aggressive – almost 5% per year growth out to 2040. There are, however, concerns around Chinese gas production, particularly related to shale gas development, which will be further discussed later in this article. Even with an optimistic view of Chinese gas production, as with oil, given the expected increases in gas demand (rising from about 4.7 trillion ft3 in 2013 to 17.5 trillion ft3 by 2040), China is expected to be an increasing net importer of natural gas.

Current Chinese oil production is more than 80% onshore, with the remaining portion coming primarily from shallow offshore developments. China’s oldest and most prolific onshore oilfields are located in the Northeast and North Central regions (notably, the Daqing and Shengli fields), while production in the interior provinces, the Central Ordos Basin (especially the Changqing field) and the western Tarim and Junggar Basins, has been growing relatively strongly in recent years. Apart from some new prospects, primarily in the western regions, China’s onshore oilfields are however, largely considered mature, albeit with substantial enhanced oil recovery activity (EOR – water or polymer injection and/or steam flood).

Current offshore oil activity is concentrated in the relatively shallow waters of Bohai Bay in the Yellow Sea, and in the Pearl River Mouth Basin in the South China Sea, with minor current activity in the East China Sea. While onshore oil production is primarily in the hands of the Chinese NOCs, offshore oil is relatively open to IOC participation.

China’s primary gas basins are in the Southwest (Sichuan Basin) and in the Tarim and Ordos Basins. Current production is primarily conventional gas, with a notable recent large discovery by CNPC in the Sichuan Basin. Offshore gas production has been primarily concentrated in the shallow waters of the Pearl River Mouth Basin in the South China Sea, but exploration is pushing into deeper water of both the South China Sea and the East China Sea. In March 2014, Husky Oil, in partnership with CNOOC, started production from the country’s first deepwater well at the Liwan development in the South China Sea. As with offshore oil, offshore gas is relatively open to IOC participation.

But the part of China’s oil and gas upstream that has sparked the greatest interest in the last few years is its unconventional gas potential, particularly shale gas. Estimates of technically recoverable shale gas resources in China range as high as 1115 trillion ft3 (EIA), with estimates from China’s Ministry of Land and Resources (MLR) and from the Chinese Research Institute of Petroleum Exploration and Development somewhat lower (855 trillion ft3 and 355 trillion ft3, respectively). With the North American shale success as a model, shale activity has been slowly building in China. Through 2013, 285 shale gas wells had been drilled in China, with total shale gas production in 2013 estimated at less than 7 billion ft3 – less than 0.2% of China’s total gas production. China’s shale gas activity and potential is discussed more fully in the final section of this article.

China’s massive coal reserves have also supported a sizeable coalbed methane (CBM) or coal seam gas (CSG) sector, with production in the North, Northeast, Southwest and Western regions. Production is slowly increasing, but there are growing challenges from technical/geological issues, regulatory issues, a lack of infrastructure, high development costs, and some mineral/land rights issues. Coal has also spurred some modest interest in coal-to-gas (CTG) projects, but high capital costs, infrastructure and water scarcity, along with emissions concerns, has slowed development.

Each of the three big NOCs is involved in each of the three distinct upstream segments – conventional onshore, unconventional onshore and offshore – but CNPC tends to focus mainly on onshore conventional, while Sinopec tends to focus more on unconventional onshore, and CNOOC primarily offshore. It is estimated that the three collectively invested around US$ 60 billion in the Chinese upstream in 2013, with some 80% of that spending going to development activities.

Looking broadly at the Chinese upstream through M&A activity data compiled by Derrick Petroleum, it shows an average of about 15 deals per year since 2006. Of the more than 120 deals, roughly 60% involved conventional assets and 40% involved unconventional assets. Activity was broadly dispersed across the upstream spectrum: 22% of the deals were for new exploration blocks, while another 22% represented farm-ins to new blocks; 15% of the deals were for undeveloped discoveries, while 13% were for discoveries under development; 16% of the deals involved producing assets, while 10% were corporate deals and the remaining 2% were mixed.

The Derrick data show that Chinese NOCs were buyers in about 16% of all upstream deals in China, while smaller Chinese companies accounted for 29%.12 The big international oil companies (the oil ‘majors’) accounted for 26% of the deals, while the international independents (both large and mid-sized) accounted for 25%. Foreign NOCs played a small role (2%), while the remaining 2% of the deals were unspecified.

The international majors’ role in the Chinese upstream has been led by Shell, Chevron and ConocoPhillips, but the other seven international majors are also participating in China, albeit generally on a smaller scale. The IOCs generally work under production sharing contracts (PSCs) and/or other types of joint ventures with the Chinese NOCs. Notably:

Shell has three shale/tight gas PSCs, two with CNPC and one with Sinopec, and is reportedly planning to spend more than US$ 1 billion/yr on Chinese shale over next five years. Shell also has a PSC with CNOOC for offshore exploration in the South China Sea.

Chevron has a big sour gas development PSC in Sichuan with CNPC and has interest in several non-operated offshore producing blocks in the Pearl River Mouth Basin and Bohai Bay, as well as an interest in two shallow water blocks in the South China Sea, where seismic/evaluation work is underway.

ConocoPhillips has an interest in two offshore producing blocks in Bohai Bay, and has joint shale gas study agreements with both Sinopec and CNPC.

Eni, Husky, BG and BP are also involved in offshore developments, some in shallow water, but also some deepwater developments.

Hess, Eni, Total, BP and ExxonMobil are also involved with shale gas developments.

International independents also have been active in the Chinese upstream, with the bigger independents including the American independents: Devon, Anadarko, Noble Energy, Newfield and EOG; and the Australian independents: Roc Oil, Arrow Energy and Horizon Oil. Notably however, Devon, Noble, Newfield and Anadarko have sold their interests in China, while two of the Australian independents have been acquired: Arrow by the Shell/CNPC joint venture and Roc Oil by the Chinese conglomerate, Fosun International.14

There are four main institutional challenges for the Chinese upstream:

General industry structure: There is a historic NOC bias which limits the participation of the international oil companies (IOCs) typically to the more technically-challenging, higher-risk opportunities (e.g. sour conventional gas, shale gas and especially deepwater), but also limits to some degree the participation of the smaller, private Chinese companies, with frequent complaints that the most-attractive opportunities are generally only accessible to the big NOCs. Nevertheless, the Chinese government is looking to improve the productivity of the NOCs and at the same time attract additional private capital support.

Energy price reform: Problems with subsidised/regulated energy prices have long plagued the Chinese refining industry as well as the upstream gas business. The government has committed to price reform and the state regulatory body, the National Development and Reform Commission (NDRC) has taken some preliminary steps, but full reform is expected to be a long and winding process.

Midstream liberalisation and expansion: Infrastructure investments will be critical to efficiently integrating China’s dispersed supply and demand centres, as well as expanding international supply access for oil, gas and LNG. In addition, particularly for gas, pipeline access is tightly controlled by CNPC – moving towards more open-access, as is currently planned, will be welcomed by China’s smaller upstream players.

Territorial disputes: Two of China’s most-promising offshore areas are challenged by territorial disputes with neighbouring countries with over-lapping jurisdictional claims. Potential development of the East China Sea gas resources is stalled by the dispute with Japan over a string of barren islands, while in the South China Sea, disputes with Vietnam and the Philippines threaten development there. Tensions recently escalated in the South China Sea when China moved a drilling rig into disputed waters. While the dispute with Japan is fraught with some long-standing political and historical issues, the Chinese government has given some subtle signals that it would be willing to work collaboratively with its neighbours in South China Sea oil and gas development.15

This article was published in the December 2014 issue of Oilfield Technology, which is available for subscribers to download here.